The Madhavpura ghost is back

Five years after its burial, the ghost of the Madhavpura Merchantile Cooperative Bank of Ahmedabad has come back to haunt over 210 urban cooperative banks. These banks had kept around Rs 200 crore (Rs 2 billion) worth of deposits with Madhavpura, but with the bank folding up, they will not get their money back.

In banking parlance, these banks' exposure to Madhavpura (in the form of deposits) has become bad and they will need to make provisions for this in their balance sheets. The problem is that around 100 of the affected cooperative banks are in no position to make such provisions.

So far, the Reserve Bank of India has looked the other way, but now plans to insist the banks do the provisioning -- in which case, these 100 banks will have to be liquidated.

Even though the epicentre of the earthquake that is set to hit the sector is Ahmedabad, cooperative banks as far away as Madhya Pradesh and Karnataka will feel the heat (nearer home, banks in Gujarat and Maharashtra will also get affected).

The rot is not limited to just Madhavpura and banks that put money in it. Over 700 of the 1,900-odd urban cooperative banks in the country are in a condition that ranges from stressed to very stressed in terms of parameters like capital adequacy and non-performing assets, barely kept alive through a life-support system. Another 300 can carry on with some extensions of deadlines for capital adequacy while around 900 are in the pink of health.

Just how bad things are can be best judged from the outflow of funds from the Deposit Insurance and Credit Guarantee Corporation -- individual deposits of up to Rs 100,000 are insured with the DICGC, and this is paid to depositors when banks fold up.

Till 2000-01, the total money paid by the DICGC was Rs 262 crore (Rs 2.62 billion) --most of this was paid to depositors of urban cooperative banks. By 2003-04, this rose to Rs 1,044 crore (Rs 10.44 billion) and was Rs 1,484 crore (Rs 14.84 billion) at the end of 2004-05. In the last two years, all the outflows have been to cooperative banks only.

Urban cooperative banks play an important role as financial intermediaries in urban and semi-urban areas, catering to the needs of the non-agricultural sector, particularly small borrowers. The total deposit liability of urban cooperative banks is to the tune of Rs 1,10,000 crore (Rs 1100 billion).

There are around 1,900 urban cooperative banks (in December 2004) in the county and close to 200 are under liquidation. In 1966, the year in which these banks were brought under the purview of the Banking Regulation Act, 1949, there were 1,106 urban cooperative banks.

Five states account for 85 per cent of these banks. Maharashtra tops the list with 639 banks and 4,333 branches, followed by Gujarat (328 banks and 1,091 branches), Karnataka (300 banks and 1052 branches), Andhra Pradesh (133 banks and 299 branches) and Tamil Nadu (134 banks and 180 branches).

Only nine urban cooperative banks have a deposit size of more than Rs 1,000 crore (Rs 10 billion) and most of them (about 60 per cent) have a deposit size of less than Rs 25 crore (Rs 250 million).

The problem lies in the fact that most urban cooperative banks are political in nature, and this is further complicated by the system of dual control. The RBI has the authority to issue licences to urban cooperative banks and cancel it but the state government (where the bank is located) is responsible for its audit, appointment of its CEO and supersession of its board.

The state government exercises this power through the Registrar of Cooperative Societies. In other words, the regulation is the headache of the RBI while the administration comes under the purview of the RCS. Often enough, the RBI may want to supersede the board but the RCS may not go ahead and do this and vice-versa.

Take the case of a 98-year-old urban cooperative bank in Hyderabad. This bank, taken for a ride by about 20 borrowers, has NPA levels of 66 per cent and has managed to wipe out its entire net worth. It has no choice but to go in for liquidation.

The RCS, however, is opposed to this and wants a one-time settlement with the borrowers who can get away paying very little as the bank is willing to settle their dues at a huge discount. In this case, the borrowers don't want the bank to go for liquidation but the depositors want liquidation because it is only then that they will get back their money -- currently, the bank has no money so the depositors can't withdraw it.

Incidentally, all borrowers are members of the urban cooperative bank but the depositors are not. The RBI wants to remove this anomaly by making the depositors also members of cooperative banks and giving them representation on the cooperative bank boards.

The regulator also has plans to sign a memorandum of understanding with the urban cooperative banks to bring them back on track. The broad contour of the plan is to have two sets of MoUs. At the first stage, an umbrella MoU will be signed with the respective state governments (through the RCS) and the RBI and at the second stage, armed with this MoU, the RCS will enter into another MoU with individual banks and give them business targets.

The RBI wants to divide the urban cooperative banks into two segments. At Tier I, there will be about 1,200 banks, which do not have presence outside of a district and have deposits of under Rs 100 crore (Rs 1 billion). At Tier II, there will be 700 urban cooperative banks, which are larger in size.

According to the plan, the Tier II banks will be treated like any other commercial banks and would need to achieve a 9 per cent capital adequacy ratio and have 90-day NPA norms (that is, if a borrower fails to pay up for a quarter, the account will turn sticky) by March 2006.

The weaker banks (falling under the Tier I category), will be given three years to fulfil all prudential norms. However, the RBI vision can only be translated into reality if the state governments are willing to sign the MoUs.

Unfortunately, most state governments are not willing to do so, for different reasons. As a result, despite its best intention, the banking regulator may not be in a position to save the urban cooperative banks.

It's a crude political time bomb ticking away and until it is defused, Prime Minister Manmohan Singh and Finance Minister P Chidambaram will not be able to walk the talk on bank consolidation.